To The Moon

On March 4, BZ topped 115 as Russian forces gradually encircled southern cities of Ukraine. Crude oil traders rushed to cancel their short orders. A large number of short sellers have gathered in this price range. The withdrawal of these short orders and upcoming long orders are likely to lead to a further spike in oil prices.

The U.S. announced 60 million barrels of crude oil will be released. But it only equals to 3-4 days of US consumption, and wartime is likely to consume more oil. With crude oil inventory data well below market forecasts, crude oil futures logically present a super-backwardation structure. It means that traders have no confidence in the short-term market supply balance.

In fact, not only crude oil futures, but also other major commodity futures are starting to exhibit a similar structure. The proportion of commodity futures with super-backwardation structure is at one of the highest levels on record. Since last November, I have repeatedly highlighted the continued strength of crude oil and commodities. If anyone has any illusions about the current strength of crude oil and commodities -- it must be Fed officials.

In 1973, Egypt, seeking to reclaim the Golan Heights and Sinai Peninsula lost in the Six Day War, raid Israel on the Yom Kippur holiday. After the holiday, the Israeli army asked US for help and defeated Egypt in an overwhelming battle. Nixon applied to Congress for financial assistance to Israel. However, Nixon deliberately delayed the application by a week, who aimed to buy time for Egypt. This, of course, was another move by the US to interfere with the geopolitical landscape: superficially, the US treated both countries fairy; but it laid the foundation for more conflicts later.

Sure enough, Arab countries didn't buy it. The oil embargo resulted in oil prices soaring four times from $2-plus to more than $12, opening up a period of Great stagflation in the United States. By 1979, after the Iranian revolution, oil prices even doubled again, until Volcker took the responsibility and saved the economy.

Currently, the dollar is appreciating, US Treasury yields are falling, and safe-haven asset prices are rising. All of this seems at odds with crude oil and commodity trends. Some Fed officials also argue on this basis that inflationary pressures will not persist. After all, no one buys bonds when there's inflation. If the bond market don’t worry about the inflation, let alone Fed.

However, there is another perspective.

After announcing sanctions against the Russian payment system, the US deliberately excluded energy from the sanctions, despite constantly stating that "Russian crude oil will not be an exception in the end". The bigger killer was the freezing of the Russian central bank's dollar reserve assets abroad and the ban on the Russian central bank providing liquidity to bail out sanctioned Russian banks. Yesterday, shares of SBER Bank, one of Russia's major banks, plunged to just a penny in London. Such dollar hegemonic sanctions have indeed hit the Russian financial system hard in the short term, but not without a backlash.

The exclusion of Russia from the dollar payment system and the freezing of the Russian central bank's dollar assets are practical ways to show that dollar assets are not so-called "safe assets". Your assets are only safe if the US recognizes them. In the short term, such sanctions do force dollar-dependent countries, especially emerging countries, to seek for more dollar assets under this background. However, after recognizing this hegemonic rule of the dollar system, these countries may remain vigilant and start developing a payment system independent of the dollar. The continuous strengthening of the RMB is just like a mirror that shows the weakness of the dollar system.

Historically, every oil crisis or oil price spike has invariably been followed by a recession in the US economy. Currently, this kind of surge in oil price is very rare. The last time we saw oil prices soar to such heights in such a short time was the 1973 oil crisis.

The Bretton Woods system crashed down in the face of the oil crisis; a new global monetary system emerged. At one time, oil was priced in gold. After the Bretton Woods system went bust, Kissinger brought the world the petrodollar system that established the hegemony of the dollar. At that time, oil would be priced at over $400 a barrel if it were denominated in gold. Without the anchor of gold, the global monetary system is like a kite with a broken string, which can fly very high in a flash, but can also fall down in an instant.

As oil soars epically, other assets are not immune. For the third time in more than three decades, German Treasuries fell by more than 20 points in a single day as Germany announced a massive increase in military spending. At the same time, the single-day implied volatility of Treasuries changed by a factor of five variance - or a probability of one in three and a half million, a theoretical one in 20,000 years. Readers who follow my research should know that the appearance of these epic price swings is no accident and hints that a new monetary system will shape. In fact, it is not impossible for countries that have been kicked out of the dollar system to return to gold. If Russia's currency were priced in gold instead of dollars, then the Russian ruble would probably be 20-30 instead of 120.

One of the relatively certain outcomes we can expect from this war is that the turmoil in the crude oil market will continue in the short term. As it remains uncertain whether the scope of sanctions will include energy, financial institutions will be indecisive to open letters of credit to refining companies. This situation is bound to further contract oil supply in the short term. Some oil traders are already seeing $200 for oil prices.

Currently, US Treasury real yields have plunged to the lowest. This scenario also happened in the oil crises of 1975 and 1980. Both of them led to US stagflation, recession, and double-dip in stock and bond markets. Many market analysts have never seen such a scene in their life.

That said, every oil crisis or oil price spike has been accompanied by a reshaping of the monetary system: 1973, 1980 and 2008. This time should be no different. At one time, Arthur Burns, the Fed chairman before Volcker, argued exhaustively why monetary policy could not solve inflation caused by structural problems such as war, and deliberately excluded oil and food prices from the calculation of inflation.

Ultimately, this economic sophistry, which was defiant in the face of a devastating economic cycle, made Fed miss a good opportunity to tighten monetary policy, which led directly to the subsequent Great Stagflation. But, it helped establish a dollar-centered monetary system. After all, Volcker showed how a central bank can double its benchmark interest rate to 20 percent during fierce inflation after credit money has abandoned gold. Volcker's move undoubtedly laid the groundwork for the subsequent credit and hegemony of the dollar, but the credit created by the pioneers has almost been lost by those who came after.

The "Modern Monetary Theory" that was so popular last year argued that no matter how the Fed prints money, inflation is difficult to get up. The core of this theory is the continuation of the credit and the hegemony of dollar is alive and well. However, if the inflation is calculated according to the original inflation calculation method before the 1970s, the CPI in the U.S. is now 15%, not 7.5%. When considering the balance of both ends of the national balance sheet, and that the Fed's liabilities are the appreciation of Americans' assets, the "Modern Monetary Theory" fails to take into account that without credit, asset prices are only inflated. Printing money only adds another “zero” to the price of assets, but the value of cash flows generated by assets does not change.

Macro changes are always silent and difficult to see, but eventually they come as a shock - like the melting of a glacier and the final avalanche. At this turning point, which currency will rule the world in the near future?